Fed Up With Federalism

By accident of its birth -- a collection of separate colonies that slowly came together to form an independent union and revolted against the remote power of the British government -- the United States has an enduring bias toward localism, an aversion to centralized government that is part of its DNA. For some on the left, this has been seen as a positive. "It is one of the happy incidents of the federal system that a single courageous state may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country," Justice Louis Brandeis once wrote.

Even though progressives such as Brandeis have celebrated our federalism, it's important to remember that Brandeis lived and worked at a time when the federal government was icebound in conservative orthodoxy and the cause of social justice could be advanced only in a small number of states and cities. Segregationists like George Wallace and Richard Russell have celebrated our federalism, too, arguing for states' rights at a time when the national government was moving to abolish the Jim Crow laws throughout the South.

Conversely, liberals have argued for the right of the nation to move beyond its federalist constraints during those periods when they controlled the national government (the 1930s and, especially, the 1960s). And during the late, lamentable Bush presidency, conservative justices on the Supreme Court frequently forbade the states from enacting stricter regulations on business than those that Bush's administration had put in place.

The love of federalism is a sometime thing; its critics and champions switch places depending on who is in power at which level of government. But the problem with our allegedly ingenious federal system is not simply that half the time, if not more, it is an effective way to protect all that is biased and unfair in the American nation. The problem is also that federalism inherently subverts a coherent national response to many fundamental challenges the United States faces, at a time when other major nations -- our competitors in an increasingly global economy -- face no such structural impediment.

Given the sheer size of America and the distinct cultural identity of its many regions, federalism has always made a certain amount of sense. The abolition of the slave trade and the legalization of gay marriage had to begin somewhere. As the rise of national government, transportation, and media have eroded regional identities, traditions, and isolation, however, more conservatives than liberals have found a refuge in federalism.

But even though federalism is more often the refuge of reactionaries than of visionaries, it has an even deeper flaw: setting the nation at cross-purposes with itself, and never more so than during a recession.

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There is a classic algebra problem in which water pours into a bathtub from the tap at a specified rate but also exits the tub at a different rate because someone has neglected to stop the drain. If you know the rates, you should be able to figure when the water will rise to a certain level. During a recession, the United States becomes a version of that bathtub. The federal government is the tap. The state and local governments are the drain.

That's no way to fight a recession. When investment, production, and consumption are all in decline, the only way to keep the economy from shrinking is for the federal government to deficit spend and create a stimulus. But while the federal government pours money in, the state and local governments, which cannot deficit spend, see their tax revenue shrinking, so they cut spending, raise taxes, or both -- taking money out of the economy. America's distinct brand of federalism inherently impedes an economic recovery.

Consider the state with the biggest tap and the biggest drain: California. The sum total of the federal tax cuts for Californians included in last year's Bush administration stimulus legislation and this year's Obama administration stimulus came to $15.5 billion for the years 2008 to 2010 -- money desperately needed to boost consumer spending in the midst of the worst downturn since the Depression, says Jean Ross, executive director of the California Budget Project. But the sum total of state tax increases enacted by the California Legislature and signed into law by Gov. Arnold Schwarzenegger in 2008 and 2009, Ross says, came to $12.5 billion for the years 2008 to 2010 -- money desperately needed to keep public services in California from grinding to a halt in the midst of the worst downturn since the Depression. "The state negated 80 percent of the feds' tax cut," Ross says. "And the cuts and the increases pretty much targeted the same lower-income groups."

Nor were the negations limited to tax cuts. Ross calculates the federal government's direct aid to education, its block-grant programs and other education-related expenditures for California total $9.5 billion from 2008 to 2010. The state government's cuts to K-12 schools, community colleges, the California State University, and the University of California add up to $17.4 billion for the same years.

California leads the fiscal--disaster pack, but it is anything but alone. A September paper from the Center on Budget and Policy Priorities reports that since the recession began, at least 41 states and the District of Columbia have slashed their budgets for a wide range of services -- 27 for health care, 25 for aid to the elderly and disabled, 26 for K-12 education, 34 for higher education, and some states for all of these. Forty-two states have reduced wages to state workers through layoffs, furloughs, and salary cuts. At least 30 states have raised taxes during the same period. "All of these steps remove demand from the economy," the center concludes. They "reduce the purchasing power of workers' families, which in turn affects local businesses."

Without the Obama stimulus, which appropriated roughly $140 billion to the states to reduce their budgetary shortfalls during 2009 and 2010, these numbers would be even worse -- though keep in mind that $140 billion in federal funds isn't engendering growth; it's merely offsetting state cutbacks. The center estimates that the federal bailout enabled states to reduce their budget gaps by 40 percent. But with state financial shortfalls in those two years coming to a whopping $350 billion, that leaves $210 billion in unrecompensed state budget shortfalls, which the states have to make up by cutbacks or tax hikes or financial gimmicks. Dean Baker and Rivka Deutsch of the Center for Economic and Policy Research estimate that the cutbacks and tax hikes of cities, counties, and school districts in 2009 and 2010 will come to an additional $15 billion.

So how much does the government's stimulus come to when we subtract the amount the states and localities are taking out of the economy from the amount the feds are putting in? The two-year Obama stimulus amounted to $787 billion, of which $70 billion was really just the usual taxpayers' annual exemption from the alternative minimum tax, and $146 billion was actually appropriated for the years 2011 to 2019. That leaves $571 billion that the federal government is pumping into the economy during 2009 and 2010. Subtract the amount that state and local governments are withdrawing from the economy (they have a combined shortfall of around $365 billion, but let's say they do enough fiscal finagling so that the total of their cutbacks and tax hikes is just $325 billion), and we're left with $246 billion.

At $787 billion, the stimulus came to 2.6 percent of the nation's gross domestic product for 2009 and 2010 -- not big enough, but a respectable figure. At $246 billion -- the net of the federal stimulus minus the state and local anti-stimulus -- it comes to just 0.8 percent of GDP, a level lower than those of many of the nations that the U.S. chastised for failing to stimulate their economies sufficiently.

But other major nations don't have federal systems that turn them into unstopped bathtubs in times of recession. They have states and municipalities, to be sure, but either the responsibility for funding most functions of government resides with the national government, or, as in Japan, state and local governments are not required to run annual balanced budgets. In China, which probably has had the most robust recovery of any major nation, taxes and spending for everything are set in Beijing (including the lower tax rates for provinces in which manufacturing for export is the main economic activity). In France, taxing and spending has been controlled by the national government at least as far back as Louis XIV. In Britain, funding for local government also comes from the national government; "local taxation," says Thomas Barry, first secretary for economic affairs in the British Embassy in Washington, D.C., "is a very small fraction of the total tax burden in the U.K."

Such is obviously not the case in the U.S. The national government alone funds defense and the two great social programs, Social Security and Medicare, created at moments (1935 and 1965) when liberals controlled both Congress and the White House. But state and local governments, which can't run deficits, remain the primary funders of education, transportation, local infrastructure, and public safety and split the cost of health care for the poor with the feds. What this means is that the governmental impediments the United States encounters during a recession are far greater than those encountered by the other major nations with which we compete in the ever more global economy. What this means is that our federal system is, in this very significant particular, massively dysfunctional.

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This September, the Los Angeles County Metropolitan Transportation Authority, the agency that runs LA's growing subway system and its far-flung bus lines, struck a novel deal with an Italian rail manufacturer. In return for its purchase of 100 light-rail cars from the company, the MTA got the company to agree to locate a unionized factory in Los Angeles. Problems with the manufacturer caused the deal to collapse, though, and the MTA is now searching for another company that will build the trains in Los Angeles. The agency's attempt to bolster local industry with a Buy-LA policy has encountered opposition, however, from the Los Angeles Times, which noted in an editorial that federal funds available for buying clean, green rail transport are denied to states and cities that insist on making the product locally. To be sure, the Obama administration has allotted billions of dollars to incubate an electric-car industry. But it is not insisting on domestic content, nor has it cut a deal with a foreign manufacturer to locate a factory here, as Los Angeles is trying to do with rails and as Southern states have done for years with foreign automakers.

The federal government doesn't do that. Well, our federal government doesn't do that. Foreign federal governments do that all the time. China has spared no expense to attract foreign manufacturers, routinely abating their taxes, holding wages in check, offering help to construct new facilities. In the U.S., states and cities woo foreign and domestic investors with an array of tax and zoning incentives; right-to-work states promise to hold down wages, too. But the kinds of sweeping guarantees that national governments can offer are beyond the capacity of states and localities to promise, much less deliver.

China, for instance, is halfway through a stunningly ambitious project to build 100 university science parks roughly modeled on North Carolina's fabled Research Triangle. On average, the parks, according to the testimony of attorney Alan Wolff to the U.S.?China Commission, are 150 percent the size of North Carolina's triangle. "China has taken our model and expanded dramatically on it," Rick Weddle, CEO of the Research Triangle Foundation, testified to the commission. "We toured a research park in Suzhou that is a joint venture between the Chinese government and Singapore. We wouldn't even think about that."

The industrial policies of American states are dwarfed by those of foreign nations, while the one entity with the resources to compete with foreign nations -- the federal government -- stays out of the game. States seek new factories while the federal government shuns domestic content requirements. As with stimulus policy during recessions, state and federal industrial policies seem totally at cross-purposes.

Federalism also enables federal and state governments to punt the responsibility for funding politically contentious programs to each other -- a pretty good way of ensuring that the programs will end up underfunded. A quick way to grasp the contrasting levels of political power wielded by the elderly (considerable) and the poor (negligible), for instance, is to look at how the government funds their health care. Medicare, for seniors, is entirely federally funded. Medicaid, for the poor, has the responsibility for its funding split between the federal government and the states. Despite the fact that Medicaid is nominally a national program, the levels of financial support that states allot it vary considerably. During the current recession, many states have opted to slash Medicaid benefits, even as federal Medicare benefits have largely stayed intact.

The perverse consequences of this hybrid funding have seldom been clearer than during the health-care reform battle, in which the Senate Finance Committee's bill to open Medicaid rolls to more Americans without pledging full federal funding for the program has presented recession-wracked states with a problem they could do without. After Gov. Schwarzenegger stated that the increased cost to his state could amount to $8 billion annually, Sen. Dianne Feinstein of California, who backs the health-reform efforts, announced that she couldn't support a bill that increased the state's costs. (In the House bill, the federal government picks up almost all of the states' increased Medicaid costs.) Federal mandates on states that must balance their budgets during recessions are problematic policy, and they illustrate the buck-passing that is inherent in the federal system. Historically, the price for this feature of federalism has been paid neither by the federal nor state governments but by the poor.

In regulatory matters, the gap between federal and state standards can work as Brandeis thought it should, but it can also enable businesses to comparison shop for the lowest level of regulations. While federalism is an effective way to create multiple governmental power centers in a nation, it creates a system that powerful private players can game. The diffusion of power inherent in federalism works best when power in the private economy and civil society is also diffused, so that, for instance, business will get push-back from labor when it attempts to arbitrage the gaps between state and federal law.

The boundary between federal and state functions in the United States has always been a flexible one, and one that has moved slowly and haltingly toward the federal level throughout most of the nation's history. By the standards of nearly every other major nation, however, and increasingly by the standard of common sense, the United States retains a system of government that frequently subverts its own policies and enables federal and state governments to negate each other's endeavors. Federalism has its points, but in a growing number of ways, and especially during a recession, it makes no damn sense at all.